Morning Report: The push-pull of monetary policy 5/14/18

Vital Statistics:

Last Change
S&P futures 2732 3.75
Eurostoxx index 391.38 -1
Oil (WTI) 70.81 0.11
10 Year Government Bond Yield 2.98%
30 Year fixed rate mortgage 4.55%

Stocks are higher this morning as trade tensions with China eased somewhat over the weekend. Bonds and MBS are down small.

The Trump Administration is pushing Congress to get a long-term funding deal done by the August recess.

There won’t be much in the way of market-moving data this week – housing starts and retail sales will be the only possibilities. We will have Fed-speak every day however.

As the yield curve flattens, it is attracting more and more attention. Chris Whalen argues that Fed manipulation of the curve is the driving force behind the flattening. By paying interest on excess reserves, the Fed has pushed up short term rates far further than demand for credit would imply – in fact he argues that if the Fed stopped paying interest on excess reserves, the Fed Funds rate would get cut in half. On the other side of the coin, fears of taking losses on its QE portfolio has caused the Fed to hold down long-term rates. Finally, he argues that the reason for the growth in nonbank lending has been due to unwritten guidance from the government to the big banks: don’t go lower than 680 on FICO scores. There is a conflict between macroprudential regulation and monetary policy, which is inhibiting credit growth despite the FOMC’s attempts to stimulate it. Whalen argues that credit growth is not high enough to really stimulate a recovery and that is due to hard caps the regulators have imposed on commercial and industrial lending, construction finance, and multifamily lending. I wonder if credit is behind the lack of housing construction despite such high demand.

As rates rise, we are seeing more and more money flow into passively-managed bond funds. One of the interesting dynamics of passively managed indices is the self-reinforcing mechanism of the investing itself. For example, look at the FAANG stocks (Facebook, Amazon, Apple, Netflix, and Google). Their weight in the S&P 500 is based on their market caps. So, as these companies outperform the S&P 500, their weighting in the index increases, which causes passive investors to buy more in order to maintain their weighting. It becomes a self-fulfilling prophecy. Here is where it gets strange in bond-land. Companies with the most debt end up dominating the index. So in theory, as a company gets more risky (by issuing more debt), passive investors demand more of their debt. So unlike passive equity investment, which builds on strength, passive bond investing builds on weakness. This means that there should be much more room for index outperformance with actively managed bond funds than with passively managed bond funds.

Interesting chart from David Stockman:

HNW to DPI

If the ratio of net worth to income is going to revert to the mean, that means either asset prices are going to crash, or incomes are going to rise. I think the latter is what will occur.

Morning Report: James Bullard thinks no further hikes are warranted 5/11/18

Vital Statistics:

Last Change
S&P futures 2722 3.75
Eurostoxx index 392.17 0.2
Oil (WTI) 71.3 -0.06
10 Year Government Bond Yield 2.96%
30 Year fixed rate mortgage 4.56%

Stocks are higher this morning on no real news. Bonds and MBS are flat.

Import prices rose 0.3% MOM and 3.3% YOY, driven by oil. Ex-energy import prices were flat.

St. Louis Federal Reserve Head James Bullard said that interest rates may already be at the level where they are no longer stimulating the economy. There are “reasons for caution in raising the policy rate further given current macroeconomic conditions” he said in his prepared remarks. Bullard has generally been considered a dove, so this is not much of a surprise. He is also a non-voter. He believes that there is little in the inflationary pressures being signaled in the market.

With respect to inflation signaling, he has a point. The spread between the 30 year bond and the 5 year bond is now the narrowest since 2007. Note that the yield curve generally flattens during tightening phases and is probably not signifying the type of deflationary period that 2007 did. Given all of the QE over the past decade, the signals from the bond markets are heavily distorted and should be taken with a grain of salt. Note short Treasuries is one of the biggest hedge fund trades on the Street.

Are the homebuilders set to outperform going forward? They have suffered more than the market during the recent declines, but the environment should be favorable for the sector going forward. With a shortage of housing, high demand and rising prices, the sector should be in good shape. The problem for investors? The sector is highly cyclical, and the stock behavior reflects that. In other words, earnings will rise and fall, and the multiple will expand and contract, dampening the effect. So, if the average multiple is typically mid-teens, don’t be surprised if P/E ratios fall to the high single digits during boom times.

Q2 GDP is currently tracking at 3.7%.

Sen Pat Toomey says that the Trump Administration doesn’t have the authority to pull out of NAFTA, since it was passed by Congress. On the other hand, the Admin does have the authority to pull out of the Iran Deal, as well as the Paris Accords because they were only deals with the Obama Administration and not the US – never ratified by Congress.

Morning Report: Inflation remains under control 5/10/18

Vital Statistics:

Last Change
S&P futures 2705 8.75
Eurostoxx index 391.2 -1.24
Oil (WTI) 71.51 0.37
10 Year Government Bond Yield 2.96%
30 Year fixed rate mortgage 4.62%

Stocks are breathing a sigh of relief after the Consumer Price Index comes in lower than expectations. Bonds and MBS are up as well.

The headline Consumer Price Index rose 0.2% MOM / 2.5% YOY. Ex-food and energy it rose 0.1% / 2.1%. Higher gasoline prices pushed the index up, while falling healthcare and communications price increases pulled it lower. While the Fed focuses on PCE, and not CPI it is a welcome development for bonds and shows that the 3% level has held again on the 10-year.

Initial Jobless Claims were flat last week at 211,000. For those keeping score at home, this is pretty much a 48 year low.

Royal Bank of Scotland will finally put the mortgage crisis behind it as it settles with the US government with a $4.9 billion fine. The fine was lower than expected and the stock is up 6% this morning in UK trading.

Want to get the absolute best price for your home? List it on Tuesday at 5:00 pm local time. No, really.

California is close to mandating that all new homes come with solar panels. The mandate will probably raise the cost of a new home by about $10,000 although the money will eventually get recouped with lower energy bills – the CA Energy Commission estimates that the typical homeowner will save $80 a month, which would more than offset the $40 additional mortgage cost. CA’s average electric bill is only $90 a month to begin with, so that $80 number seems suspect.

The White House is looking to keep Interim BCFP Director Mick Mulvaney in for a longer period, at least through the end of the year. The WH is rumored to want NCUA Chairman Mark McWatters as the permanent head of the CFPB. McWatters is viewed as a pragmatist and has a reputation for working with people on both sides of the aisle.

Morning Report: Number of job openings equals number of unemployed 5/9/18

Vital Statistics:

Last Change
S&P futures 2680 9.75
Eurostoxx index 390.81 0.81
Oil (WTI) 70.9 1.84
10 Year Government Bond Yield 3.00%
30 Year fixed rate mortgage 4.63%

Stocks are higher this morning after the US pulled out of the Iran deal. Bonds and MBS are down, with the 10 year trading over 3% again.

The Iran deal was never ratified by the Senate, so it never reached the level of “treaty.” It was basically a deal with the Obama Admin and Iran.

Oil had a volatile day yesterday and is rallying again. China is the biggest customer of Iranian oil, so in theory it shouldn’t affect the US all that much, but WTI will follow Brent on the relative value trade. Note that a sustained oil price over $70 is estimated to be about a 0.7% drag on GDP growth.

Inflation at the wholesale level moderated last month, with the producer price index rising 0.1% MOM and 2.6% YOY. Ex-food and energy, the index rose 0.1% / 2.3% and the core rate rose 0.1% / 2.5%.

Job openings hit 6.6 million last month, which is a new record for the index, which goes back to early 2000. The quits rate increased to 2.3%. The quits rate has been stuck in a 2.2% – 2.3% range for what seems like forever. Fun fact: The number of job openings has hit the number of unemployed for the first time.

The labor shortage is particularly acute in construction, which is part of the reason why housing starts have been short of demand. This shortage has extended to home remodeling as well.

While everyone seems to focus on the CPI / PPI / PCE inflation measures and imagines that a single point estimate accurately reflects the cost of living, it doesn’t. First the relative weights of different goods and services differ. For example, PCE and CPI will weight healthcare differently, as well as owner-equivalent rent. The St. Louis Fed notes that the differences in inflation between regions of the US can be substantial as well.

Mortgage Applications fell 0.4% last week as purchases fell 0.2% and refis fell 1%. Tough times for the smaller originators.

Despite the slim pickings out there, mortgage credit has contracted a bit this year. Overall, it was a mixed bag, as government credit contracted on less streamlines while conventional increased as jumbos rose. Government credit has been tightening since early 2017, when the government began to crack down on serial VA IRRRL shops.

How have things changed at the CFPB or the (BCFP) under Mick Mulvaney? Despite the ululating in the press, not that much. One of the panelists warned industry lawyers not to advise their clients that the CFPB is relaxing its enforcement activities. So far, the biggest change we have seen is that the name has been changed back to the Bureau of Consumer Financial Protection, which was the way it was written into Dodd-Frank.

Fair Housing groups are suing HUD over Ben Carson’s delay of the Obama-era re-interpretation of AFFH – affirmatively furthering fair housing. Their complaint is that HUD didn’t provide advance notice before suspending the rule,. which would have required communities to “examine and address barriers to racial integration and to draft plans to desegregate their communities.” HUD delayed the compliance deadline until 2024. In practice, this means that HUD wants communities to change or eliminate their zoning ordinances to include more multi-family housing in wealthier neighborhoods.

Morning Report: Schneiderman gone 5/8/18

Vital Statistic:

Last Change
S&P futures 2667 -3
Eurostoxx index 388.93 -0.56
Oil (WTI) 70.09 -0.62
10 Year Government Bond Yield 2.96%
30 Year fixed rate mortgage 4.55%

Stocks are lower as we await the Trump Administration’s decision on the Iran deal. Bonds and MBS are down small.

The Administration is set to announce later today whether they intend to stay in the Iranian deal or abandon it. Oil has been rallying on expectations Trump will leave.

Jerome Powell said that market expectations (i.e. the Fed Funds futures) are more or less in alignment with the Fed’s expectations for the future path of interest rates. The December Fed funds futures are predicting about a 10% chance of one more hike this year, a 44% chance of 2 more and a 39% chance of 3 more. Over the past month, the central tendency has become more hawkish.

Small Business Optimism remains strong, according to the NFIB. More businesses are planning on increasing capital expenditures, while hiring remains strong and we are seeing evidence of increased compensation. Profitability increased as well, which indicates that productivity is increasing, and that some of this CAPEX is going towards labor-saving technology. Finding qualified workers continues to be the biggest issue surrounding small business. “There is no question that small business is booming,” said NFIB Chief Economist Bill Dunkelberg. “Consumer spending, the new tax law, and lower regulatory barriers are all supporting the surge in optimism across all small business industry sectors.”

Despite the hurricane-related spike in delinquences, overall DQ rates have been falling, according to CoreLogic. Home price appreciation, in addition to more stringent underwriting standards are the driving force behind it. The foreclosure rate is down from 0.8% to 0.5%, and the 30 day DQ rate is down to 4.8% from 5.0%. As you would expect, TX and FL are experiencing rising DQ rates, but the rest of the nation is down.

Tesla stock has more or less recovered from its conference call induces swoon from last week. The bonds are at the lows however, trading at 88. Note there is a divergence also in NFLX, which has bonds in the low 90s, while the stock is a highflyer.

NYS AG Eric Schneiderman resigned from office after reports came out that he abused 4 women. Schneiderman was an AG cut in the same cloth as Eliot Spitzer, and hated the financial industry about as much as he did (FWIW the feeling was mutual). When Spitzer announced his resignation, cheers went up on the floor of the NYSE.

Freddie Mac is getting into the business of providing lines of credit against MSR portfolios. Nonbank servicers face liquidity issues when loans they are servicing go delinquent. They are required to make the mortgage payment to the ultimate investor of the mortgage until the loan is brought current or foreclosed. Banks generally have no problems with this, but nonbank issuers generally don’t have the balance sheet to withstand heavy advances activity. Fannie Mae only requires 6 months of advances, but Ginnie Mae has no similar relief. Policymakers are concerned about the ability of nonbank servicers to withstand a period of prolonged stress if delinquencies spike.

Homebuyer sentiment hit an all-time high according to the Fannie Mae Home Purchase Sentiment Index. “The latest HPSI reading edged up to a new survey high, showing that consumer attitudes remain resilient going into the spring/summer home buying season,” said Doug Duncan, senior vice president and chief economist at Fannie Mae. “High home prices and good economic conditions helped push the share of Americans who think it’s a good time to sell to a fresh record high. However, the upward trend in the good-time-to-sell share seen since last spring has done little to release more for-sale inventory. The tightest supply in decades, combined with rising mortgage rates from historically low levels, will likely remain a hurdle for mobility and a persistent headwind for home sales.”

Morning Report: Goldilocks moment with unemployment and inflation 5/7/18

Vital Statistics:

Last Change
S&P futures 2670 6.9
Eurostoxx index 388.46 1.44
Oil (WTI) 70.62 0.89
10 Year Government Bond Yield 2.94%
30 Year fixed rate mortgage 4.54%

Stocks are higher this morning as oil tops $70 a barrel. Bonds and MBS are flat.

Jobs report data dump:

  • Nonfarm payrolls 164,000 (lower than estimates)
  • Unemployment rate 3.9%
  • Average hourly earnings +.1% MOM / 2.6% YOY
  • Labor force participation rate 62.8%

This was the second month in a row where the labor force participation rate fell. The labor force fell by 236k, while the population increased by 175k. Wage inflation remains present, however it is still unlikely to drive higher inflation in the overall economy. The unemployment rate fell to the lowest since early 2000. This report takes some pressure off the bond market, and makes another run at 3% for the 10 year less likely.

The drop in the unemployment rate along with moderate wage growth is somewhat of a Goldilocks moment for the Fed. The Philps Curve is an older economic model which suggests that inflation should rise as unemployment falls, which makes sense: Unemployment falls -> workers become scarce -> wages rise -> those costs get passed on to consumers. In reality, the relationship between unemployment and inflation has been weak (R^2 = .27). The low r-squared gives away the weakness of the model – it is too simplistic, plus the unemployment rate might not be the best measure of employment strength since it ignores the long term unemployed. However, if you look at the plot below, you can see we are at a very “Goldilocks” point, which is denoted by the yellow star.

Phillps Curve

The upcoming week will have the consumer price index and the producer price index, but that should be the only market-moving data. We will have some Fed-speak as well today and Wednesday.

Donald Trump has until May 12 to renew the Iran deal. Israel calls the deal fatally flawed, while Iran says the US will regret not renewing it. West Texas Intermediate is trading over $70 on fears the deal will not be renewed.

Doctors tend to have difficulties getting a mortgage early in their careers – they usually have a high level of student loan debt, no savings and the earnings early on can be low. Mortgages that carry a higher interest rate but don’t require downpayments are becoming more popular for this market. These loans can carry an interest rate 25 -100 basis points over prevailing rates. although they usually don’t require PMI. One catch – the prepay speeds on these mortgage will almost certainly be high.

The CFPB dodged a bullet – PHH will not appeal the DC Circuit’s ruling that rejected their claim that the single-director structure is unconstitutional. There are other cases in the process that also use that claim, so it is possible the question may come to SCOTUS. If one of these cases makes it to SCOTUS, the only one with standing to defend the agency is the Administration, who probably won’t defend it.

Merger news: Mutual of Omaha is buying Synergy One. Synergy One will be a wholly-owned subsidiary and will continue to operate out of San Diego.

Morning Report: The Fed maintains rates as expected 5/3/18

Vital Statistics:

Last Change
S&P futures 2622 -5.75
Eurostoxx index 385.94 -1.5
Oil (WTI) 67.7 -0.21
10 Year Government Bond Yield 2.94%
30 Year fixed rate mortgage 4.58%

Stocks are lower after the Fed maintained interest rates. Bonds and MBS are up.

As expected, the Fed maintained its current Fed Funds target yesterday. The money quote: Inflation on a 12-month basis is expected to run near the Committee’s symmetric 2 percent objective over the medium term. Risks to the economic outlook appear roughly balanced. The “symmetric” characterization of their inflation target (as opposed to treating the 2% target as a ceiling) gave markets some comfort that the Fed is going to continue its slow upward march in the Fed Funds rate as long as inflation remains around these levels. Bonds initially fell on the news and then rallied.

The Fed Funds futures are pricing in a 100% chance of a tightening at the June meeting, and the December futures are pricing in one more tightening this year, with a smaller chance of 2.

Job cuts fell in April after an unusually strong March, according to outplacement firm Challenger, Gray and Christmas. Retail has accounted for the largest share of job cuts this year, followed by health care. For the year, companies have announced around 175,000 job cuts, while announcing 210,000 job plans. C&G uses press releases to count job cuts and hirings, so it necessarily relate to the payroll numbers being put out tomorrow by BLS.

Productivity rose 0.7% while unit labor costs rose 2.7% in the first quarter, according to BLS. Weak productivity growth has been an issue for a while and is one of the reasons why wage growth has seemed muted. Increases in standards of living are driven by increases in productivity. The increase in unit labor costs may be related to many of the minimum wage hikes we saw at the beginning of the year. Theoretically, the lower the productivity, the less room the Fed has to maneuver.

Initial Jobless Claims rose slightly to 211,000 which is still close to 50 year lows.

The service sector continues to expand, albeit at a slower pace than March according to the ISM Non-Manufacturing Index. The respondents echoed the same trade fears as the manufacturers did. Some snippets:

  • “Economy is humming along. [Activity in] both residential and commercial construction [is] apparent. Agriculture sector seems to be moderating at these commodity price levels. The international trade situation appears to be shifting on a minute-by-minute basis, which has folks nervous.” (Finance & Insurance)
  • “National shortage of Class-A drivers and the increased demand for logistics is resulting in an increase in the cost of goods.” (Accommodation & Food Services)
  • Construction activity continues to remain strong in the region, resulting in capacity issues and shortages of labor, materials and subcontractors.” (Public Administration)

Bill Gross thinks the upward move in interest rates is pretty much done, and he doesn’t see much more of a move from here. “Supply from the Treasury is a factor in addition to what the Fed might do in terms of a mild, bearish tone for U.S. Treasury bonds,” Gross told Bloomberg TV. “I would expect the 10-year to basically meander around 2.80 to perhaps 3.10 or 3.15 for the balance of the year. It’s a hibernating bear market, which means the bear is awake but not really growling.”Of course Bill is talking his book a little, but he is probably right, with the caveat that inflation remains around the 2% level.

Beware of cult stocks once they lose favor with the Street. Tesla’s conference call was supposedly a disaster last night, and Elon Musk decided to take questions from You Tube people instead of analysts who were interested in things like cash burn. Comparisons are being drawn to Enron’s conference call in the early 00s when Jeff Skilling blew up at analysts which caused people to take a more critical look at the company. Don’t forget TSLA bonds have been getting slammed, and that is toxic for a stock with negative cash flow trading over 4x revenues.

Fannie Mae results are out. The company made $4.3 billion in the first quarter.

Big fixed income money managers have not had much of an appetite for MBS as QE pushed down returns. That may be changing, as BlackRock and BNP Paribas are allocating more funds to the sector. One big advantage of MBS is liquidity. What does this mean for mortgage originators? Lower rates, at least at the margin.

%d bloggers like this: